Jumping Off the Ledge

Why the Nation Needs the Fiscal Cliff

By Jacob Fass

If the media and some politicians are to be believed, Jan. 1, 2013 will bring with it the much-dreaded “fiscal cliff.” This will result in massive spending cuts and onerous tax increases, grabbing hold of the floundering economy and dragging it, kicking and screaming, into a cataclysmic recession. There seems to be a cottage industry of sorts designed to elicit fear about the expiration of the Bush tax cuts and the large-scale sequester cuts to military and domestic spending, with the hope that it will push Congress toward a grand bargain in the four weeks before the deadline.

But the only thing we have to fear is fear itself. It’s true that the full implementation of the “cliff” would lead to a significant drag on the economy, but this is based on an unrealistic assessment of the situation. The fiscal cliff will undeniably be resolved in one way or another. The question is whether the cliff will be resolved in the interests of President Obama and the slim but tangible majority of voters who elected him, or instead in the interests of the party that was rejected on Nov. 6.

First, some background: in the summer of 2011, with a newly installed Republican majority in the House of Representatives propelled to office by the fiery anger of the Tea Party, the Obama administration made the unfortunate decision to negotiate with the Republican accuses over raising the debt ceiling. This was a procedural act that had been once been accompanied by grandstanding and posturing, but now the House Republicans were using it to force large spending cuts in the middle of a tepid recovery. Failing to raise the debt ceiling would force the Treasury to default on America’s debt, a move that likely would have actually had devastating and irrevocable consequences.

Was it a good idea to reduce spending in the midst of a fledgling economic recovery with rock bottom interest rates and declining public employment? Probably not. But having agreed to engage in these hostage negotiations, the President requested that large cuts in spending, which would fall mainly on middle class and poorer Americans, would be accompanied by some revenue increases that would hit the wealthiest Americans. The agreed-upon ratio was three dollars in cuts to every one dollar in revenue, an agreement heavily tilted toward the priorities of House Republicans. It called for far less revenue than the vaunted Simpson-Bowles commission did, but it remained unacceptable to large swaths of the Republican caucus.

The President and Congressional Republicans were unable to reach a Grand Bargain on the order of $4 trillion in deficit reduction, but they did agree to raise the debt ceiling. They kicked the proverbial can down the road and set up automatic spending cuts of over $1 trillion in domestic and military programs set to launch in 2013 if Congress were unable to finish the $4 trillion dollar deal. The sequester cuts, though particularly brutal to many domestic and defense programs, exempted entitlements and was designed to spare the most vulnerable Americans. Still, the sequester was particularly unpleasant to the interests of both parties in order to push a more comprehensive deal before the budget axe fell.
Congress and the President completed the deal knowing that nothing would be resolved until after 2012. Now that the election is over, the same players have returned to Washington. But the policy and political contours of the battle have shifted. With the expiration of the Bush tax cuts scheduled to occur as the same time as the sequester cuts, the revenue and spending sides of the equation have been melded together politically as well as policy-wise. If the 2012 election was about anything substantive, it was about ending the Bush tax cuts for the top two percent of earners. The President focused almost myopically on the issue, and down-ballot Democrats in blue states and red states alike echoed his creed of repealing tax cuts for millionaires and billionaires. Obama’s victory on Election Day sealed the public mandate for this approach.

Republicans and Democrats realize that if Congress does nothing, everyone’s tax rates will increase, from waiters’ to private equity investors’. Both parties will strongly agree that taxes should be lower for the vast majority of the population and will move quickly to pass taxes for those citizens, to avoid the wrath of angry middle class voters and to spare the country from the brunt of recession if those higher middle class taxes are allowed to stay in place, just as consumer spending and the deleveraging of debt begins to pick up across the country. This will leave President Obama in a commanding position. He will be able to determine the size and scope of those middle tax cuts. Congress will also want to reverse some of the immediate spending cuts while focusing more on long term entitlement reform. Again the President will be able to take the lead, pressing for entitlement changes that stem the rising cost of health care, as the Affordable Care Act has begun to do, instead of the arbitrary benefit caps pushed by House Republicans. Most of the tax increases and spending cuts, especially the defense cuts unacceptable to Republicans, will be quickly reversed. While allowing all these changes to take effect would eventually have devastating impact on the economy, a deal in January will relieve almost all of the fiscal drag.

So while groups like Fix the Debt and financial leaders like Ben Bernanke fret about the impact of the fiscal cliff, it is obvious that the cliff will never actually be fully implemented. By January 2013, the deficit will be in the unusual position of being too low, and both parties will have been able to reach a deal to raise deficit, which is always a more politically appetizing prospect. But the terms on which the deal would be reached would be very different. They would be far more favorable to the interests of President Obama and Senate Democrats. Why, as talks have taken on the air of Kabuki theater, do House Republicans seem sanguine about the failure of talks? Why aren’t they rushing to negotiate with the President knowing full well they will be in a better position now than after the ball drops in Time Square?

It seems to me that House Republicans and the President realize that they will get different things from the failure to produce a grand bargain before Christmas. The President will able to achieve many of his policy objectives that he campaigned on so vigorously. The House Republicans will have a political issue; they will be able to campaign on lower taxes without having voted to raise them. Even the much despised anti-tax activist Grover Norquist seems to recognize this reality; in a recent speech, he claimed that Republicans would be fine as long as they didn’t have “their fingerprints on the murder weapon,” or the act of voting for higher rates. The only people who seem to desperately want such a quick deal are the moderates who supported Simpson-Bowles, the Republican Senators who seem to care more about the policy implications than the political consequences, and the processions of so-called “gangs” who want the parties to come together and make the tough choices on fiscal issues. To them, the failure of the talks would be diametrically opposed to their interests.

But they are mistaken. If you want comprehensive and serious reform of entitlements and a tax code that is more pro-growth and raises far more revenue, if you worshipped the Simpson-Bowles plan and were disappointed when President Obama did not vigorously campaign on it despite quietly supporting many of its provisions, then you have to be willing to go over the fiscal cliff. When all the taxes rise on Jan. 1, Congress will have a new baseline to work with, a baseline much friendlier to the kind of innovations that would be far superior to our current ill fangled tax code. Otherwise, the math simply does not work. Mitt Romney tried fruitlessly to make it work during the campaign. Even Simpson-Bowles assumed that all the Bush tax cuts would expire before changes to the code could be made.

Sometimes the focus of much the Washington policy establishment on the debt, as the equivalent of our fight with Nazi Germany or the dissolution of the Union, seems to be misguided. Our high short-term deficit is largely a consequence of low tax revenue from the vicious recession we just experienced and the costs of the largely successful if insufficient efforts to pull the economy out of this ditch. Despite the investor class’s hand-wringing, its members seem perfectly content buy to buy United States treasury bonds. Interest rates, the worst economic consequence of high deficits, have never been lower. But in the medium term, our low tax burden and the ever-rising costs of health services will begin to become problematic, crowding out the more productive activities of both the public and private sector. Taxes will need to go up and the rate of spending on entitlement programs will need to go down.

Fortunately, we do not need a poorly convinced grand bargain in the next couple of weeks that relies on ultra-conservative House of Representatives to act heroically against type. Despite their clashing, politicians of both parties have inadvertently ensured that incentives line up perfectly to deal with some of our revenue and spending problems early next year. President Obama is fond of saying that the arc of history is long but it bends toward justice. At times it seems that the system in Washington is actually constructed to lead to senseless and unjust outcomes, but sometimes things turn out differently. Even as commentators warn of catastrophe as the deadline approaches, in a few weeks the country can bend the arc of history toward some measure of economic and fiscal sanity. That sanity, more than the illusion of bipartisan consensus, would truly make for a sweet new year.

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